The luster of gold always takes on an extra sheen in uncertain times. In the wake of September 11, the Argentinean crisis and the Enron Corp. scandal, the price of gold has begun to rise again. In February it topped $300 an ounce for the first time in two years, up 12.73 percent over the past six months. And demand is gaining: Long-suffering Japanese consumers, for example, are trading in their weakening yen for kilos of the stuff.
For Wayne Murdy, CEO of Newmont Mining Corp., the upturn could not have come at a better time. After five quarters of net losses, the Denver-based gold mining company turned the corner in Murdy’s first full year as CEO, posting earnings in the final two quarters of 2001. Newmont’s stock sold recently at about $24 per share, near its 52-week high. In January the company won a two-month-long battle with South Africa’s AngloGold to take over Australia’s Normandy Mining, as well as Normandy’s largest shareholder, Toronto-based Franco-Nevada Mining Corp. When the deal is done (shareholders gave their approval February 13), Newmont will be the world’s largest gold mining company, with 88 million ounces of proven reserves and 8.2 million ounces in annual production.
Newmont had cash flow of $381.3 million for 2001 on sales of $1.66 billion. After merger costs and noncash items, however, it reported a net loss of $30.8 million, or 16 cents per share. How does a company lose money mining gold? Easy, says Murdy. “The industry is not sustainable at $275 an ounce.”
A CPA, Murdy, 57, admits he’s embarrassed to have to tout earnings before interest, taxes, depreciation and amortization rather than net income, as if his were some telecommunications or cable company. Now, thanks in part to a large discovery that’s approaching full production in Yanacocha, in northern Peru, and the rising price of gold, he can talk about net income again.
Murdy joined Newmont in 1992, after nine years as an auditor for Arthur Andersen and 15 years in the oil industry. He became president in 1999 and CEO in November 2000. Recently, Murdy discussed Newmont’s prospects with Institutional Investor Assistant Managing Editor Subrata N. Chakravarty.
Institutional Investor: What makes gold such a valuable commodity?
Murdy: It’s the only reserve asset that is not somebody else’s debt. The Japanese government has recently put limits on the guarantees for savings in bank accounts, so we’re seeing an increase in the number of Japanese people buying gold. It’s always marketable: In many parts of the world, you can go down to the corner and sell your gold. In India, gold jewelry is the savings account for most families, especially the women.
Why go after Normandy Mining?
Our strategy is to be in a few places but to be there in real scale. Our core assets are in northern Nevada - we’re the biggest landholder there after the federal government. We’ve been there for 35 years and will be there for another couple of generations. A second core asset is Yanacocha in Peru, probably one of the best gold mines in the world. We control 51 percent; the Peruvian company Buenaventura and the International Finance Corp. own the rest. We control 525 square miles near there. It’s going to be big, and it’s going to be a major producing region, not just one mine. A third big production area is the Batu Hijau mine on Sumbawa in Indonesia, which we built between 1997 and 2000. It produces copper and gold. When I came in as CEO last year, I said we’d work on the balance sheet and political risk. When this transaction came up, it was an opportunity to accelerate both of those objectives.
The deal was very complex.
It’s a unique transaction. I’m not sure anybody ever has done something like this before. Three countries - the U.S., Canada and Australia. One part of it was contested with the South Africans. That’s what gets lost in this. Everyone sees this as a fight with AngloGold for Normandy. But we’re acquiring Franco-Nevada in Canada, and they own 19 percent of Normandy. Franco-Nevada is an extremely successful royalty company, with no debt and a $2 billion market cap, a huge cash position, and a royalty income stream that basically has no costs against it. They are merchant bankers, not miners
When Anglo made the unsolicited offer, it completely surprised Franco. That’s when we started talking about the three-way transaction.
How does it fit your strategy?
It addresses our balance sheet issues. Franco has $700 million in cash, no debt. It gives us a natural hedge from the royalty income stream - that’s about $60 million a year. In a low-gold-price environment, that’s a neat thing to have. With Normandy it gives us a big position in Australia, a politically secure country. On a combined basis, 70 percent of our production will come from triple-A-rated countries. We can be in [riskier places like] Indonesia and Peru, where the big new discoveries will come from. So it addresses the political risk. It gives us growth opportunities. Basically, it’s a portfolio approach.
What was the final price?
About $5.2 billion for both companies. The cash component of the deal is $460 million. We’re doubling our market cap. The rewarding thing was that the big institutional holders have been buyers. Our largest shareholder is Fidelity Investments. The second largest is Capital Research & Management Co.
Yanacocha sounds like El Dorado.
There’s a lot of gold there - a 36 million-ounce reserve. A number of deposits, not just one mine. What makes it different is that the ore is very porous. The gold comes out pretty quickly.
Why did the gold price drop so low?
Gold production basically doubled from 1980 to 2000. Part of that was technology-driven, primarily in the ‘80s with the development of heap leaching, which allowed you to process very low-grade ores. But the laws of supply and demand still apply, and a slide in the price took place that was compounded by a lot of producers hedging their production.
Why is hedging a problem?
Unlike other commodities, there’s not a natural counterparty in a gold hedge. What happens is that people borrow the gold from central banks, sell it physically into the market, take the proceeds and invest them in Treasury bills. That’s the “contango” [a commodities trading term]. Central banks will loan the gold at very low rates - 1 percent, 1.5 percent. So when interest rates were at 5 or 6 or 7 percent, there was a nice contango that caused more gold to hit the market. Annual consumption of gold is about 3,800 tons worldwide. Annual production is about 2,700. So this drop we’ve had to $275, has been driven not just by increasing production but by the increasing hedge game.
With the drop in the interest rates, that hedge game doesn’t look so good. In addition to production falling off, producers will deliver into their hedges - i.e., give the gold back to the central banks - and that gold won’t hit the market. So it has the opposite effect.
Meaning what?
The cumulative hedge in this industry is 4,700 tons. That’s almost a year and three quarter’s worth of production. If just a small portion gets turned back in, it has a dramatic effect [on the price].
You talk a lot about operating cash flow rather than net income.
That’s because at $275 an ounce, we don’t make any. As a former auditor it makes me uncomfortable. The name of the game is net income and that’s our goal. The average price of gold through the 1990s was $340 an ounce. We make very good returns at $350 or $340.
Where do you see Newmont going in the next five years?
We have a very strategic investment in Uzbekistan with the government. If they develop into a free-market economy, if they ever privatize, they’ve got one of the biggest mines in the world, the Maruntau. We’d like to be able to get in there.
Where do you see gold prices going?
We think that over the next two to three years you could easily see a move back to the $350 range. It could be much better than that. If you look at what’s coming off production and you look at the hedge books that people have and are going to be forced to deliver into, we think that makes a very good case for gold.
